The Indian Power Sector has been weighed down by the political and regulatory environment along with the inefficiencies of the State Electricity Boards (SEBs) and chronic shortages and pressures to meet demand.This has deterred private investment from flowing into the sector. The government's first stab on this i.e. the 1990s strategy of bringing in global sponsors to build Independent Power Producers (IPPs) was not particularly successful and Dhabol plant left a bad taste in everyone’s mouth. But with the passage of Electricity Act 2003, new rays of hope have opened for growth. The Electricity Act has an overall positive impact on the profitability of the power sector and encourages investment and efficiency. The new power strategy visible in India has much more of a domestic flavour even though bidding is open to foreign players.The government is keen to attract significant private capital into its power sector, which is facing a huge demand-supply gap. Badly affected states such as Maharashtra have 19% energy shortages, and this can rise to 27% peak power shortage levels. This power shortage is holding back industrial growth and corresponding economic development, and the World Bank has estimated that if India is to sustain current GDP growth levels in the 8% to 9% per annum range, it will need to add 160,000 MW of generating capacity over the next 10 years.

The basic template evident is domestic sponsors raising cash on the stock market,and using this source of funding as the project equity component for competitive bids. In this new environment, Project Finance will be the key financing mechanism for growth. Also the investment will have to be directed towards all the components of the electricity delivery chain i.e. Generation, Transmission and Distribution. This would help India to overcome the bottlenecks in the long neglected Transmission and Distribution segments. The financing also needs to move to the next level of Public Private Participation with the Financial Institutions providing equity to the sector and not just debt. The sector also needs incentives in the form of lower duties, tax holidays and measures such as a higher return on equity (RoE) to attract more investments.

Payment risks associated with SEBs which has been a major concern for IPPs have overcome to some extent with SEB restructuring and improvement in the security and payment mechanisms arrangements. But a word of caution needs to be attached to this optimistic view as the efficacy depends on the commitment of the Centre and State machinery to the reforms process. Except for the limited success by a few generation companies in accessing the debt market, transmission and distribution utilities have not managed to raise debt successfully from the open market. The availability of easily accessible debt from government backed financial institutions like the Power Finance Corporation (PFC) and the Rural Electrification Corporation (REC) has had the effect of "crowding out" the development of a private debt market. It is therefore important that these institutions scale down their activity, and confine themselves to the smaller and weaker utilities. The state utilities are too cash strapped for internal resources to be of any significance. Given the excellent commercial potential of merchant power plants, the equity market is a good source of raising funds. In any case, the Indian equity and especially debt market is too narrow and does not have the required depth and breadth to finance these huge requirements. It is therefore inevitable that Foreign Direct Investment (FDI) be incentivized, so as to meet the huge investment requirements.